What happened
Oil prices are sinking again today, with WTI, the U.S. benchmark price, slumping about 4% by 1:00 p.m. EDT to less than $52 per barrel. That marks a more than 20% decline from oil's most recent high in late April, plunging crude into another bear market.
Oil's latest tumble is understandably weighing on oil stocks, with several slumping double digits at one point in the day. Among the notable decliners are Whiting Petroleum (WLL), Denbury Resources (DNR), Laredo Petroleum (LPI -2.14%), Oasis Petroleum (OAS), and Carrizo Oil & Gas (CRZO).
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So what
Crude is under pressure today after the U.S. Energy Information Administration (EIA) put out its weekly inventory report, which showed a considerable increase in supplies. According to the EIA's data, oil storage levels in the country rose by 6.8 million barrels last week, which is quite a surprise given that analysts anticipated that they'd decline by 900,000 barrels. This unexpected inventory buildup seems to confirm the oil market's fears that the trade war between the U.S. and China is negatively impacting oil demand.
Lower oil prices have a direct effect on the cash flows of oil producers, which is why most oil stocks are falling today. However, it has an even more meaningful impact on financially weaker oil companies, which is why Whiting, Denbury, Laredo, Oasis, and Carrizo are selling off so sharply today.
Take Denbury Resources, for example. The oil company's financial situation is so weakened that it cut its budget range by 20% to 25% compared to last year's level. As a result, its production will decline by about 4% this year. Denbury reduced spending so that it could produce some excess cash to help chip away at its $2.5 billion in debt. With oil prices in the $60s earlier this year, Denbury was on pace to produce more than $150 million in free cash flow. However, at $50 oil, the company would only generate between $50 million and $100 million in excess cash -- which, at the low end, would barely make a dent in its debt level.
We find similar stories at Whiting Petroleum, Oasis Petroleum, Laredo Petroleum, and Carrizo Oil & Gas. Both Whiting and Oasis, for example, ended the first quarter with leverage ratios of 2.4 times debt to EBITDA, which is well above the industry's target level of 1.0 to 1.5 times. Meanwhile, Carrizo and Laredo were a bit better, though both have leverage ratio's closer to 2.0 times. Because of that, interest payments on their debt consume a larger portion of their cash flow, which only gets worse when oil prices decline.
Now what
Oil prices have been all over the place in the past year. While that volatility impacts the cash flow of all oil companies, it has a greater effect on those with weaker financial profiles. That's why we're seeing such big sell-offs in these oil stocks today.
While there might be a temptation to buy one of these beaten-down oil producers in hopes of a bounce back if crude prices rally, that's not a wise idea. That's because these oil companies will likely continue struggling until they get their finances back on solid ground, which could take years to accomplish.
